The Greek Crisis: Yes, It's That Bad

Greece is now a virtual EU colony, waiting from bailout to bailout, each preceded by months of negotiations, more harsh austerity measures, riots, and an increasingly fractured political system.

The latest installment has been delayed by a growing rift between the IMF and their EU partners in Greece’s guardian, called the Troika. The IMF has looked at the ever-deepening EU recession and Greece’s inability to pay back debts given its own declining economy. It now wants to scale down future loans.

The IMF is hardly being radical. Its incredibly modest goal is that by the year 2020 Greece will only hold public sector loans amounting to 120 percent of its gross domestic product. That’s double the international norm. Yet even this basic goal probably won’t hold. In Europe, politics systematically trumps sound economic policy, and the ideology of a single currency zone precludes any rational discussion.

Germany, however, has elections coming up, and the government is not relishing having to tell taxpayers why their money is being spent on loans to Greece that will never be repaid. So there is now talk of an amazing compromise in which each EU state will decide how much it can give Greece without facing domestic political costs. This gives a good view of the EU method in such matters: the issue isn’t really dealt with, the crisis is kicked down the road, and the political elite declares victory.

The 44 billion euro loan Greece is expecting would just cover immediate obligations at best. For example, Greece has been staving off default by issuing short-term treasury bills that it dumps onto its commercial banks. It isn’t surprising that this practice has brought on the insolvency of the banking system, whose capital was wiped out last spring in the last debt restructuring. So much of the new money will be used to refund the banks, which will then be put under the control of the Troika. Hence, Wolfgang Munchau of the Financial Times called Greece the first formal EU colony.

In this cycle that solves nothing, bailout loans prevent Greece from defaulting on its foreign debt. As might be suspected, this is a Ponzi scheme that inevitably will eventually collapse. Greece is loaned money to pay back old loans and the interest mounts.

Successive Greek governments (always the same policies and mostly the same people) are terrified that they won’t receive the next bailout loan installment and thus won't be able to pay state employees or debts, not to mention foreign creditors. No one takes into account the effect of this mess on the Greek economy or the Greek people in bringing deepening recession and declining living standards.

Naturally, the Greeks then miss most of the targets set as supposed conditions to get the loans, sometimes due to bad administration, but more often due to simple economics. Deepening recession means declining tax revenues -- as incomes drop and businesses go bankrupt -- and rising public expenditure due to mass unemployment and impoverishment of the population.

On paper, Greece seems to be making progress as its balance of payments turns positive. But that’s only because the depression is reducing imports. As for things that would make a difference -- like opening closed professions and more labor flexibility -- these reforms could take a decade to show results and there is a great deal of resistance to making any substantive changes.

The popular myth, of course, is that tax revenues are never on target because of rampant tax evasion. One of Greece’s distinct features is a very large percentage of the labor force being self-employed. Most businesses are small and family-owned. This social category forms the backbone of the Greek middle class. In the U.S. and Western Europe, the percentage of self-employed is below 10%, while in Greece it is a whopping 30%.

According to IRS statistics, self-employed people are prone to heavy tax evasion from systematic understatement of income. That factor would explain most of the tax revenue shortfall. The EU authorities would like to eliminate the large number of small businesses, which they see as inefficient.